Deck 16: Advanced Topics Concerning Complex Auditing Judgments

Question 1

Auditors make materiality assessments to help in planning the audit evidence to obtain and in evaluating the audit evidence that was obtained.

Answer 1

True

Question 2

In performing substantive analytical procedures, the threshold for determining whether differences between the client's recorded balance and the auditor's expectation should be based on planning materiality.

Answer 2

True

Question 3

If a company's net income varies significantly from year to year, the auditor might consider using an average of the net income from the prior three to five years as the materiality benchmark.

Answer 3

True

Question 4

The significant judgments of "Assets of Held-for-Sale Operations" are subject to impairment testing based on the most likely sale or disposal price.

Question 5

If the auditor believes that misstatements aggregating approximately $50,000 would be material to the income statement, but misstatements aggregating approximately $100,000 would be material to the balance sheet, the auditor typically assesses overall materiality at $100,000 or less.

Question 6

Planning materiality helps the auditor determine the extent of audit evidence needed in order to provide an opinion on the financial statements.

Question 7

Materiality judgments are made in light of the surrounding circumstances, but need not necessarily involve both quantitative and qualitative considerations.

Question 8

The inventory account does not require any subjective estimates by management.

Question 9

Existing professional guidance notes that auditors must make materiality assessments for purposes of (1) audit planning and (2) evidence evaluation after audit procedures are completed.

Question 10

The significant judgments related to "deferred income taxes" are subject to estimates of future profitable operations against which the deferred asset might be utilized.

Question 11

The auditor considers materiality only at the overall financial statement level.

Question 12

The significant judgments related to "net finance receivables" include assessing the allowance for noncollectibility.

Question 13

Complex audit judgments and decisions often involve accounts that require subjective estimates by management.

Question 14

The purpose of making materiality judgments is to make sure that financial statements are free of any material misstatement.

Question 15

Determining materiality is based solely on quantitative factors.

Question 16

Auditor needs to assess disclosures about what lines of business the company may discontinue.

Question 17

An auditor's consideration of materiality is a matter of professional judgment and is influenced by the auditor's perception of the needs of users of financial statements.

Question 18

Auditors are not responsible for making judgments regarding the fair value of securities.

Question 19

There are systematic processes that the auditor can use in making most of the complex judgments in the financial statements.

Question 20

Auditors are constantly challenged to evaluate the quality of a client's estimates, including areas such as obsolescence of inventory, allowance for doubtful accounts, and tax provisions among others.

Question 21

The SEC issued SAB 108 in 2006, which mandates what is termed a dual approach to assessing uncorrected misstatements.

Question 22

If the market value of the reporting unit is below book value and a significant amount of goodwill exists, the presumption is that there has been an impairment of goodwill.

Question 23

Goodwill arising from many acquisitions can be netted into one test at the company level.

Question 24

Because of conservatism considerations, auditors should allow a client to overestimate its reserve for restructuring.

Question 25

Auditors can choose to test the client's warranty reserves using primarily tests of controls and substantive analytical procedures.

Question 26

Auditors request the client to book all known misstatements, even if the recording cost is very high so that there are no carryovers from year to year.

Question 27

The assessment as to whether a misstatement in a cash-flow classification is material should be primarily based on an income statement perspective.

Question 28

The SEC's position is generally that if management refuses to correct a material misstatement, then the auditor is obligated to issue a qualified or an adverse opinion on the financial statements.

Question 29

Goodwill has to be evaluated for impairment once a year, as well as on an interim basis as the time events and circumstances warrant.

Question 30

Misstatements detected during the audit that were initially deemed to be immaterial need not be summarized to determine their aggregate effects.

Question 31

The accumulation of which potential misstatements to accumulate for the purpose of assessing the materiality of misstatements is often based on whether items are considered clearly trivial.

Question 32

Auditors may consider only quantitative effects and not qualitative effects in making materiality judgments.

Question 33

A misstatement that is intentional is not assessed any differently by the auditor than a misstatement that is unintentional.

Question 34

When auditing pension obligations, the auditor will likely use a specialist to assist the audit team.

Question 35

The iron curtain method for assessing materiality focuses on assuring that the year-end balance sheet is correct and considers the impact of prior-year uncorrected misstatements reversing in later years.

Question 36

The discovery of an intentional misstatement, even if immaterial, could impact the auditor's opinion on the effectiveness of the client's internal control over financial reporting.

Question 37

When evaluating identified misstatements, the auditor only needs to consider misstatements in the current year, and not misstatements from the prior year.

Question 38

A materiality level where the auditor believes that the errors below that level would not, even when aggregated with all other misstatements, be material to the financial statements is often based on whether something is considered clearly trivial.

Question 39

Goodwill is the excess of the purchase price over the fair market value of the acquired company's tangible assets, identifiable intangible assets, and liabilities.

Question 40

The auditor need not inform the audit committee about adjustments arising from the audit that were considered to be material.

Question 41

Level 1 assets is a broad category of assets and applies to financial instruments, property, or lower of cost or market considerations for inventory, loans, or receivables.

Question 42

When auditing financial hedges, the auditor should understand the product, identify relevant risks and controls, and understand the appropriate accounting.

Question 43

Assuming that other assets have been properly valued, if the market value of the reporting unit is equal to the carrying value of the assets of the reporting unit, the presumption is that goodwill has been impaired.

Question 44

Evidence of fraud, whether or not material, on the part of senior management, would likely cause the auditor to conclude that the client had a material weakness in internal control over financial reporting.

Question 45

If restructuring charges are not calculated correctly, the charges can be used to fraudulently manipulate income.

Question 46

The volume of transactions affected is one of the critical criteria in assessing identified internal control deficiencies.

Question 47

U.S. accounting standards require organizations to use a two-step process to determine the impairment of goodwill.

Question 48

An audit of Level 1 assets is likely to be less challenging than an audit of Level 3 assets.

Question 49

Audits of Level 3 assets are the most straightforward as they involve an observable, active market.

Question 50

Independence of the internal audit function is obtained by giving the Chief Audit Executive (CAE) unrestricted access to the board and senior management.

Question 51

When assessing fair value of Level 2 assets, auditors will use information on the sale of identical items in active or inactive markets as a source of audit evidence.

Question 52

A sensitivity analysis of changes in value based on industry and cash-flow assumptions is one of the aspects of the audit program for goodwill impairment testing.

Question 53

While performing goodwill impairment testing, if the original reporting unit no longer exists because operations have been fully integrated into operations of the parent company, the approach would be to determine whether all other assets have been adjusted to fair value, where applicable.

Question 54

In the U.S. a CPA firm can provide both internal and external audit services for the same public company client.

Question 55

Internal auditors can perform both consulting services and assurance services.

Question 56

A compensating control would not be considered as a factor that could mitigate a potential material weakness.

Question 57

The significant judgments related to debt depend on specific accounting rules (U.S. or international) that the company is following.

Question 58

In assessing the fair value of Level 1 assets, the auditor can perform an analysis of the volume of trading activity as part of obtaining audit evidence.

Question 59

Current FMV of assets and liabilities of non-goodwill assets is one of the factors affecting goodwill impairment valuations.

Question 60

When there is a ready market for financial instruments, the audit procedures related to valuation and disclosures are more straightforward than when the instrument is not readily marketable.

Question 61

Which of the following statements is not true about materiality judgments?

A) The auditor's consideration of materiality is influenced by the auditor's perception of the needs of users of financial statements.
B) The auditor considers materiality only in relation to classes of transactions, account balances, and disclosures.
C) Materiality judgments are used to help the auditor gather sufficient appropriate evidence about whether the financial statements are free of material misstatement.
D) Materiality decisions differ from one audit client to another.

Question 62

Although different audit firms take different approaches, performance materiality could be the same as overall materiality, or could be a percentage of overall materiality. Generally this range is which of the following?

A) 25% to 75% of overall materiality.
B) 50% to 75% of overall materiality.
C) 25% to 50% of overall materiality.
D) 40% to 75% of overall materiality.

Question 63

Which of the following best describes the nature of assets of held-for-sale operations?

A) Impairment testing based on most likely sale or disposal price.
B) Impairment testing if plants are closed or equipment is not used.
C) Lower of cost or market impairments, including an allowance for obsolescence.
D) Estimates and assumptions made in preparation of the estimate of income tax expense for the year.

Question 64

In which of the following cases is it not necessary for an auditor to revise the original materiality level and document the new materiality amount, as well as the rationale for changing the amount?

A) If there is a change in circumstances that involve laws, regulations, or the accounting framework.
B) If there is new information resulting from the risk assessment of the client.
C) If there are changes in the understanding of the client about a new contractual agreement.
D) If the client plans to change depreciation methods for new plant assets procured in the future.

Question 65

Which of the following statements is not true regarding the use of a judgmental approach by auditors in determining whether a misstatement is clearly trivial?

A) The determination is based on past auditor experience.
B) The determination is usually not very defensible to third-party users.
C) The determination is usually not very defensible to regulators.
D) The determination uses percentages for the likelihood of misstatement.

Question 66

Which of the following statements best describe an issue related to inventory?

A) Impairment testing based on most likely sale or disposal price.
B) Subject to allowance for noncollectibility.
C) Lower of cost or market impairments, including an allowance for obsolescence.
D) Subject to estimates made regarding the expected life of the assets and the appropriateness of the depreciation method.

Question 67

Which of the following would not be a reason to lower the threshold for materiality?

A) The auditor is concerned with potential violations of debt covenants.
B) There were proposed adjusting entries to a particular account in prior years.
C) The consequences of a potential misstatement in an account balance are very high.
D) The audit team wants to limit the amount of time spent at the client's facilities.

Question 68

Almost every asset and liability account requires significant judgments. Which of the following judgments is subject to allowance for noncollectibility?

A) Inventories.
B) Marketable securities.
C) Other receivables.
D) Deferred revenue.

Question 69

For nonprofit entities, appropriate benchmarks for materiality judgments would include which of the following?

A) Total assets and total liabilities.
B) Total revenues and total assets.
C) Total liabilities, total income, or total assets.
D) Total expenses, total revenues, or total assets.

Question 70

What document is prepared so that auditors can aggregate potential misstatements in order to assess the materiality of misstatements?

A) The audit opinion.
B) The summary of unadjusted audit differences.
C) The summary of earnings trends.
D) The post-closing trial balance.

Question 71

Which of the following is subject to fair value assessment?

A) Marketable securities.
B) Inventory.
C) Property that will be sold.
D) All of the above could require fair value adjustments.

Question 72

According to SAB 108, what approach is used when assessing uncorrected misstatements?

A) Matrix approach.
B) Dual approach.
C) Percentage approach.
D) Judgmental approach.

Question 73

Which of the following statements is false regarding materiality judgments?

A) Materiality judgments are a matter of professional judgment.
B) Materiality judgments depend on the needs of a reasonable person (an investor, potential investor, or other stakeholder) relying on the information.
C) Materiality judgments involve both quantitative and qualitative considerations.
D) Materiality judgments are easy for auditors to make.

Question 74

All internal auditors are required to have the CIA designation in order to practice internal auditing.

Question 75

When a client has significant and nonrecurring charges to nonoperating expenses, which of the following would be the most appropriate materiality benchmark?

A) Net profit.
B) Income from continuing operations.
C) Cash inflows.
D) Cash outflows.

Question 76

Which of the following will the auditor will not consider when making a materiality determination?

A) Potential default on loan covenants.
B) Changes in segment earnings or trends in earnings.
C) Factors that would affect the market's perception of future growth and cash flow for the company.
D) All of these insights would be considered.

Question 77

Performance materiality helps the auditor to determine which of the following?

A) Extent of audit evidence needed.
B) The specific analytical procedures to perform.
C) The specific substantive procedures to perform.
D) Control risk assessment.

Question 78

Which of the following is an approach used to determine posting material?

A) Dual approach.
B) Percentage approach.
C) Qualitative approach.
D) Planning approach.

Question 79

Which of the following is least likely to require significant auditor judgment about the dollar amount to be disclosed in the financial statement?

A) Contingent liability related to pending litigation.
B) Assumptions made in preparation of the estimate of income tax expense for the year.
C) The value of inventory.
D) Cash on hand at the end of the year.

Question 80

Which of the following is not a factor adding to the complexity of materiality judgments made by auditors?

A) Regulators pay particular attention to the judgmental aspects of auditor materiality decisions.
B) SEC regulators do not believe it is appropriate to use percentage terms to substitute for a full analysis of all relevant considerations regarding the magnitude of misstatement.
C) Regulators focus on how materiality decisions can affect client financial results.
D) SEC regulators have few requirements for auditors to comply with since the AICPA fills that role.